British Pound edges higher on weaker Dollar as UK political, growth risks cap gains

• GBP/USD rises toward 1.3390 on Tuesday, supported by a weaker US Dollar after easing tensions between Israel and Iran.
• Markets have shifted their expectations for the Bank of England and now price in a rate hike before the end of the year.
• UK political uncertainty and concerns about economic growth continue to limit the British Pound’s upside potential.

GBP/USD trades around 1.3390 on Tuesday at the time of writing, up 0.42% on the day, mainly benefiting from a weaker US Dollar (USD) following confirmation that direct attacks between Israel and Iran have ceased. The easing geopolitical backdrop reduces demand for safe-haven assets and weighs on the Greenback, providing support for the pair.

However, the British Pound’s (GBP) gains remain limited despite a shift in monetary policy expectations in the United Kingdom (UK). While markets had previously expected the Bank of England (BoE) to deliver two rate cuts this year, the outlook has been completely reversed. Investors are now pricing in a 25-basis-point rate hike before the end of the year, according to estimates cited by CNBC.

At first glance, this development may appear supportive for the British currency, but several factors explain why the market reaction remains restrained. First, expectations for tighter monetary policy reflect concerns about persistent inflation, particularly driven by higher energy prices, rather than an improvement in the economic outlook. Investors fear that higher interest rates could be implemented in an environment of weak growth or even economic stagnation.

BBH argues that the current backdrop leaves the British Pound vulnerable to a correction against the US Dollar. The bank believes that higher rates in an economy facing stagflationary pressures are not necessarily bullish for the currency, although they may help cushion the downside.

Meanwhile, political developments continue to weigh on market sentiment. UK Prime Minister Keir Starmer’s authority has been weakened by several government resignations, increasing uncertainty about the country’s political stability. This situation encourages investors to remain cautious despite expectations of a more restrictive monetary policy stance.

On the Bank of England (BoE) side, some Monetary Policy Committee (MPC) members are advocating for a near-term rate increase. However, Société Générale believes these policymakers are likely to remain in the minority and expects the central bank to adopt a more cautious approach at upcoming meetings.

Investors are now focused on the upcoming UK Gross Domestic Product (GDP) data release and US inflation figures. These reports could shape expectations for both the Bank of England and the Federal Reserve (Fed), and ultimately determine the next direction for GBP/USD.